Receivables Finance | 2024 Guide

Last updated on 15 Aug 2024

01 Feb 2021 . 5 min read

The above Supply Chain Finance techniques have been defined by the Global Supply Chain Finance Forum (BAFT, EBA, FCI, ICC and ITFA)

Geoffrey Wynne

Geoffrey Wynne is a partner and head of Sullivan’s Trade & Export Finance Group and the firm’s London office. Recognised as one of the leading trade finance lawyers globally, Geoff advises major trade finance banks and financial institutions around the world on trade and commodity transactions in virtually every emerging market and works on structured trade transactions covering a wide range of commodities. Geoff also acts extensively for industry bodies including BAFT, ITFA and the ICC on documentation and rules promulgated by them in trade finance. He has recently been involved with issues across the trade finance spectrum including the move towards digitising of trade documents. Geoff was given a Lifetime Achievement Award by RFIX in 2024 and is recognised as a leading lawyer by Chambers UK, the Legal 500, UK and IFLR1000.

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Receivables Finance

Welcome to TFG’s receivables finance hub. Find out how our team can help your company unlock working capital from accounts receivable financing, on both a recourse and non-recourse basis. Alternatively, learn more about the different types of receivables and receivables finance: be that from a discounting or factoring perspective, or through our latest research, information and insights, right here, in our receivables finance hub.

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What is receivables finance?

Simply put, receivables finance comprises:

Any arrangement providing credit to a party, using an amount payable by one party to another for goods or services, should be included in the scope of receivables finance.

The generation of receivables is a key factor in any trade finance arrangement. A party (the seller) sells something to another party (the buyer), and the payment by the buyer, until the time when it is paid, is a receivable. It is an asset which the seller has, and a liability which the buyer has. The speed with which the seller converts the receivable into cash is important for their business; faster conversion of receivables into cash reduces the amount of working capital the seller needs to run its business. The measurement of how long that takes is often called ‘days sale outstanding’ (DSO). The seller will often be looking for solutions that turn its receivables into cash more quickly.

On the other hand, the buyer wants as much time as possible before they must pay the receivable. The more quickly it has to pay, the more working capital it needs for its business before it can utilise whatever it has bought. The longer the buyer has to pay, the better it is for the buyer. The measurement for the buyer is its ‘Days payable outstanding’ (DPO). See also Chapter 8: Cross-border supply chain finance.

Given this apparent conflict, it is possible to see how each party might seek help to achieve a shorter DSO period, in the case of the seller, and a longer DPO period, in the case of the buyer. It is for these reasons that the parties seek solutions in the arena of receivables financing.

Diagram: How receivables finance actually works

We teamed up with the International Trade & Forfaiting Association (ITFA) to put together this diagram on how a receivables purchase agreement works between a buyer and a finance provider

How do receivables arise?

Receivables represent the culmination of most, if not all, trading arrangements where a product or service is sold, and which can result in some form of financing. It may well be the case that, in the time from producing a raw material to creating a finished product, there is more than one sale and purchase involved. The producer of raw materials sells them to a buyer. That buyer processes the raw material and sells the finished product to another buyer, and so on. Each of these sales and purchases would create a receivable, which could be the subject of a financing.

In all these cases, either of, or both, the seller and buyer might see the need to obtain financial support for such a transaction. Equally, such a transaction provides an opportunity for a financer to offer an arrangement to one or other party to improve its DSO or DPO position, whichever is relevant. In addition, other parties have become more involved in arranging for this to happen and more parties have become interested in participating in such arrangements. All of these scenarios are considered below.

Quality of the receivable

The quality of the receivable is a major determining factor as to what financing is available when it is produced in a trading arrangement. A financer might require, or offer, some sort of credit enhancement for that receivable. This might be by way of a guarantee of the payment obligation of the buyer, or by way of some other form of credit support like credit insurance or involving a surety. Another way of improving the quality of the receivable is by making it an irrevocable payment obligation. This can be in terms of the receivable itself, or because the receivable is replaced by something such as a separate irrevocable payment undertaking (IPU) or promissory note, which, by statute, constitutes an irrevocable obligation to make the payment. In order to achieve this, the buyer must give up its rights to stop payment if goods are faulty, although it may retain the right to claim against the seller.

As will be seen below the potential for using electronic negotiable instruments has the ability to increase receivables financing and introduce more investors to receivables finance.

Similarly, the timing and likelihood of a payment will affect the value of the receivable from a financing point of view. A financer may well be prepared to finance a seller who needs time to produce the product being sold and then further time to transport it to the buyer. The financer will look at the time from production to the time the buyer is obliged to pay and calculate the cost of financing that receivable and its value at various times until payment is due. By contrast, a seller who produces an invoice which states payment is due in, say, 30 days has a more valuable receivable.

How can a receivable be financed?

Once the quality of the receivable is ascertained, the question of how to finance it becomes simpler to answer. Where the receivable has not become an unconditional payment obligation, certain types of financing may not be available. For example, a financer may not want to purchase a receivable, or find a purchaser for that receivable, where the seller has to perform further actions to turn the receivable into an unconditional payment obligation. Whether the financer is taking any performance risk on the seller is a key element to consider in financing a receivable.

Once a receivable becomes an unconditional obligation of the buyer, then the credit risk of the buyer is the main issue to consider. In many ways, this is a more quantifiable risk.

Excerpts from the text of the Guide, updated by Geoffrey Wynne who originally authored the chapter ‘An introduction to receivables finance’, are reproduced with permission from Deutsche Bank AG, Sullivan & Worcester UK LLP and ITFA.

The full paper can be downloaded here.

How can receivables finance benefit my business?

Is factoring receivables a good idea for your business? Here are some of the key benefits of receivables finance:

The receivables financier will sometimes take on the responsibility to look after your sales ledger which means more time to focus on the business
A receivables financier will conduct know-your-customer or due diligence on clients and suppliers, in order to assess and price any possible risk of default
Receivables discounting can also be done in a confidential manner (confidential receivables discounting), which means that your clients won’t know that you are using a discounting facility; one for consideration when it comes to reputation
Receivables finance can also help businesses grow their trade lines and fulfil customer orders without having to worry about working capital and cash flow cycles

How can TFG help?

The TFG receivables finance team works with the key decision-makers at over 270 banks, funds and alternative lenders globally, assisting companies in accessing receivables finance facilities.

Our team are here to help you scale up to take advantage of both your domestic and international customers. We have product specialists based around the world, from automotive and vehicles, to media and data.

Often the financing solution that our clients may require can be complicated, and it’s our job is to help you find the appropriate receivables solutions for your business.

Read more about Trade Finance Global and our team.

Want to learn more about receivables finance?

Look no further! Here you can find our latest features, receivables research and trending articles in the world of accounts receivables finance. So put your feet up, and dig in to the latest thought leadership and interviews from the TFG, listen to podcasts and digest the top stories in the world of receivables finance right below.

Case Study

Receivables Finance ( Virtual Creators Inc )

Virtual Creators is a hardware start-up that is looking to expand its business. This firm sells its goods in mass quantities to online and brick & mortar retailers. They produce their goods in Shenzhen and have recently moved to a new producer in the region. Virtual Inc does not have any prior affiliation with this new manufacturer. The latter does not offer trade credit and requires immediate payment on the arrival of goods at the U.S. port.

Virtual Creators keeps its gross margins fixed at 40% at wholesale to their retail buyers. However, the retailers do not pay before the end of 60-day period after getting the product. Virtual Inc depends upon receivables finance to generate the cash required for the immediate payment that its manufacturer needs upon the arrival of goods at the U.S. port.

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If you have an invoice finance enquiry, please use the contact form.

Otherwise, you can reach us on the email addresses below.

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Finance Queries:

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FAQ

What’s the difference between invoice discounting and invoice factoring?

Invoice finance is a type of receivables finance, which includes factoring and discounting.

Factoring is present when a business assigns their invoices to a third party and the factoring company has full visibility of the sales ledger and will collect the debts when due.

The customer has knowledge that the invoices have been factored. (This is the typical route a lot of funders offer, however – some can offer Confidential Factoring)
Factoring gives businesses up to 90% pre-payment against submitted invoices
This enables improved cashflow, and reduces the need to wait for payment
The company may receive their funds up to two days after invoices are sent out. Many factoring companies will offer to send money same day (TT Payment, usually carries a charge) or by BACS (Free)
A business can choose a ‘selective’ factoring or invoice discounting facility, dependent on the funder.

Typically, with Invoice Discounting, the borrower will have more control over their ledger. Again – like factoring, there is the option to do this on a completely confidential basis.

Invoice discounting is an alternative way of drawing money against the invoices of a business
The business retains control over the administration of their sales ledger
Invoice discounting usually involves a company reconciling with their invoice financier monthly
With factoring – each individual invoice is uploaded – with Invoice Discounting, a bulk figure is uploaded and then drawn down against with the monthly reconciliations showing where money is allotted to
Under a selective facility a business can opt to factor (i.e. lend) or invoice discount just some of the submitted invoices
A selective facility is a good option if a business needs a certain amount of cashflow guaranteed each month or if one or two customers are good payers.

The main difference between factoring and invoice discounting is that with factoring, a funder will have full visibility of your sales ledger and maintain this by chasing debts on your behalf. Invoice discounting on the other hand, allows you to keep your credit control in house but as we already discussed, it would require a monthly reconciliation with the invoice financier. Naturally, management fees for invoice discounting are usually a lot lower, however a company must demonstrate they have the correct procedures in place to support an Invoice Discounting facility.

What is factoring?

Factoring solutions offer the seller of a receivable a wider service than just the advance of funds to shorten its cash conversion cycle as the entity buying the receivable will also usually take on the responsibility of collecting the debt.

Factoring can take several forms. For example, a factor may agree, subject to limits, to buy the whole of a seller’s receivables. This is known as whole turn-over factoring. Conversely, a factor may select which invoices he wishes to buy. It can be with or without recourse to the seller and may or may not be notified to the buyer or obligor.

The vast majority of factoring is domestic and individual invoices are often of a low value. Cross-border factoring is possible using the two-factor system. One factor is in the buyer’s country (known as the ‘Import Factor’) and the other in the seller’s country (known as the ‘Export Factor’). The two Factors establish a contractual or correspondent relationship to service the buyer and the seller respectively under which the Import Factor in effect, guarantees the receipt of funds from the importer and remits payment to the Export Factor. Typically, the two factors use an established framework such as the General Rules for International Factoring (GRIF), provided by FCI. Read more about factoring here.

What is invoice discounting?

Invoice discounting solutions tend to focus on shortening a seller’s cash conversion cycle, as opposed to encompassing debt management and collection aspects. The degree of disclosure to the debtor under this type of facility varies, ranging from full disclosure to no-disclosure, depending on the level of comfort taken by the purchaser of the receivables over the nature and standing of the seller. In most cases, the greater the control the financing entity/purchaser of the receivables manages to attain over the process, the better the discounting conditions offered.

An invoice discounting facility without disclosure to the debtor will grant the seller of the receivables full confidentiality, and therefore avoid reputational hazards. Most invoice discounting is without recourse to the seller so as to ensure de-recognition of the receivables from the seller’s balance sheet (so-called “true sale”) but recourse is normally retained for commercial dispute e.g. where the buyer refuses to pay because the goods or service are defective. Read more about invoice discounting here.

How do interest rates work in invoice finance and how much is advanced?

Rather than waiting 30 – 90 days, an invoice financier can pay for most of the invoice amount up front, and the interest rate is the amount charged for this service. Interest rates are often linked to base rates the bank will pay for borrowing money, such as the LIBOR, as well as a management fee.

At first instance, invoice finance lenders can advance around 90% of the invoice amount value up front, whether that be through invoice discounting or factoring. Once the invoices are paid by the end customer, the borrower will be paid the remaining difference, excluding interest rate and management fees. Even if the company has existing finance arrangements such as an existing bank loan or overdraft, invoice discounting or factoring may still work for a business.

Normally, a lender will analyse the business prior to implementing a factoring or invoice finance facility. They may audit the financial records of the business and list the approved customers, and the decision is down to legal and contractual implications such as security and existing lenders.

What is the cost of an invoice finance facility?

The company should always read the offer letter and look at all (including the following) costs:

Discount costs
Service or management fees (including the minimum service fee which is normally derived as a % of the service fee)
Audit charges
Re-factoring charges
Transactional costs
Notice period for ending service and associated fees
Annual service costs
Trust account costs
Additional costs for services such as credit protection

What is needed for invoice finance?

There are three parties involved directly in invoice finance:

the funder who advances money against the invoice or receivable
the business (or customer) who sends out the invoice
and the debtor who is required to pay for the invoice

A brief explanation: The receivable, associated with the invoice for services or goods acts as an asset and provides the company the legal right to collect money from the debtor. A percentage of funds are then advanced against the value of the invoice.

What’s the difference between invoice discounting and invoice factoring?

Invoice finance is a type of receivables finance, which includes factoring and discounting.

Factoring is present when a business assigns their invoices to a third party and the factoring company has full visibility of the sales ledger and will collect the debts when due.

The customer has knowledge that the invoices have been factored. (This is the typical route a lot of funders offer, however – some can offer Confidential Factoring)
Factoring gives businesses up to 90% pre-payment against submitted invoices
This enables improved cashflow, and reduces the need to wait for payment
The company may receive their funds up to two days after invoices are sent out. Many factoring companies will offer to send money same day (TT Payment, usually carries a charge) or by BACS (Free)
A business can choose a ‘selective’ factoring or invoice discounting facility, dependent on the funder.

Typically, with Invoice Discounting, the borrower will have more control over their ledger. Again – like factoring, there is the option to do this on a completely confidential basis.

Invoice discounting is an alternative way of drawing money against the invoices of a business
The business retains control over the administration of their sales ledger
Invoice discounting usually involves a company reconciling with their invoice financier monthly
With factoring – each individual invoice is uploaded – with Invoice Discounting, a bulk figure is uploaded and then drawn down against with the monthly reconciliations showing where money is allotted to
Under a selective facility a business can opt to factor (i.e. lend) or invoice discount just some of the submitted invoices
A selective facility is a good option if a business needs a certain amount of cashflow guaranteed each month or if one or two customers are good payers.